Have Governments And Banks Learned Nothing From The 2008 Financial Crisis?

Government Bonds And Consumer Debt Levels Soar While Bailouts Remain The Norm!

This is an excellent read from an article at City Journal! These are some of the general takeaways…

Some Key Points:

• ‘Bailouts remain the norm worldwide’
• ‘In 2008, the world’s major central banks held little more than $6 trillion in assets, according to Yardeni Research. Today, they hold nearly $17.8 trillion’
• ‘Globally, over the summer, $13 trillion in high-quality debt traded at negative interest rates’
• ‘During the summer, Italy’s government sold $5.6 billion in 50-year bonds, at an interest rate of less than 3 percent—far lower than the rate at which Italy could borrow for two years’ time after the 2008 crisis’
• ‘As people can’t earn a return on supposedly safe government and corporate bonds, they turn to the stock market, incurring higher risk’
• ‘In November, New York’s Federal Reserve branch reported that defaults on auto loans are rising. No wonder: subprime borrowers—people with credit scores below 620—have borrowed nearly $350 billion, surpassing in 2015 their pre-recession peak.’
• ‘The world has more debt today than ever: $152 trillion, according to the IMF. In the U.S., total public and private debt stands at $46.3 trillion, nearly 18 percent higher, after inflation, than in 2008’

‘In Debt They Trust‘ by Nicole Gelinas
Governments’ addiction to cheap money is blocking financial-market signals about the economy.

A decade ago, the United States and much of the West descended into an economic crisis caused by excessive debt. Americans had simply borrowed more than they could afford to repay. The debt, though, masked more complex long-term problems. Due to upheavals caused by both global trade and technology, for example, working-class and middle-class workers hadn’t received raises adequate to keep up with the rising cost of living. The extra debt—fueling the purchase of houses, cars, and consumer goods—allowed people to keep spending as if they had more money.

This mountainous debt was the product not of markets but of government planning. The United States, on a bipartisan basis, had long encouraged its ever-larger financial firms to keep lending, mostly because neither political party wanted to address the deeper economic problems confronting workers. Starting in 2007, free markets—or what was left of them—tried to warn the planners: their way of doing business had failed, and the U.S. couldn’t keep it up. That year, lenders began to pull back, their appetite for risking money on lower-quality borrowers dwindling. The next year, lenders cut off the debt flow entirely, and the global financial crisis began. As markets suddenly regarded much of the nation’s private debt—chiefly mortgages but credit-card and auto-loan debt, too—as less likely to be repaid, the firms that had dealt in that debt began to topple.

The financial crisis would have caused lots of pain no matter what governments did in response. But leaders took what may turn out to have been the worst course of all—and one that could ultimately cause even more pain: trying to solve a debt crisis by creating yet more debt. In doing so, they have, at best, suppressed and, at worst, destroyed the vital signals that financial markets send about excesses and scarcities, risks and rewards.

When no one knows what anything is worth—a fair statement describing financial markets today—no one can know what, rationally, to invest in. Irrational investments, in turn, result in a less productive economy. Regardless of the policymaking goal—whether it’s higher-paying private-sector jobs or more public-sector social spending—this outcome is untenable.

Few people think much about the hidden infrastructure of a free-market economy: the stock and bond markets and the commodities markets for raw goods, such as oil and gold. These trading and investment markets determine prices. If investors believe that prospects for a company are good, they’ll purchase its stock, and thus increase the stock price, rewarding earlier investors who first saw the firm’s potential. Higher oil prices, in turn, can spur needed investment in complex energy-development projects; lower iron-ore prices can lead firms to close unproductive plants. Markets aren’t perfect: they’re prone to herd mentality and bubbles and can be manipulated. But the imperfect information they provide is far better than nothing.

Global bond markets play a particularly critical role because their activity affects all other markets. Money borrowed in bond markets gets invested in other assets, such as property, or in resources, such as factory equipment, that create jobs. Dysfunction in bond markets can thus wreak havoc with the global economy.

When firms or individuals buy bonds, they’re lending someone else money. In turn, the company or person who sells the bond (usually through an investment bank) is borrowing money. When more investors want to buy bonds than sell them, the price of the bonds goes up, and interest rates—the annual percentage that borrowers pay on their debt—fall. When more investors want to sell bonds than buy them, the reverse happens: the price of the bonds goes down, and interest rates go up, because fewer people want to lend money.

What causes investors to change their assessment of whether to buy bonds or to sell them, and consequently to help lower interest rates or raise them? First, they look at expected government behavior. The Federal Reserve, America’s central bank, sets the interest rate at which large banks borrow and lend among themselves. If investors think that this rate will rise, they’ll likely charge a higher interest rate, in advance, on their own lending. Second, they consider expected economic growth and inflation. If an investor charges a 3 percent annual interest rate for lending his money, but inflation looks to be 5 percent, he will lose money in real terms. Thus, if high inflation is expected, investors will charge higher rates. Investors also contemplate the risk of default. An investor will charge higher interest to a company that might go bankrupt. Finally, investors consider time. A bond that matures next year is usually less risky than a bond that matures in 30 years, because as time goes on, the chance that the unexpected will happen grows.

Bond markets are complicated, in part because all these factors work together. If inflation is high, for example, a healthy city with little debt could end up paying, effectively, a 7 percent interest rate on its debt: a 5 percent interest rate for inflation, plus an extra 2 percent for low risk. But if inflation is low, a distressed city with massive debt could end up paying a lower effective interest rate: 1 percent for expected inflation, plus an extra 4 percent for high risk. Markets try to discern these signals, which have beneficial effects on the real world: a city that has spent years ignoring its pension obligations actually benefits from investors charging it a higher interest rate, which encourages it to reform before it’s too late. Similarly, someone likely to default on an auto loan probably shouldn’t get a loan at all, because a default will hit her credit rating and end up costing her more money. A prohibitively high interest rate sends this signal, too.

Read the rest of the article at City Journal here.

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